Steelcase Inc (SCS) 2005 Q2 法說會逐字稿

Good day everyone and welcome to Steelcase's second quarter earnings conference call.

As a reminder, today's conference call is being recorded.

For opening remarks and introductions, I would like to turn the conference call over to Mr. Terry Linhardt, Vice President of Corporate Strategy and Investor Relations.

Sir, you may begin.

Thank you, Jennifer.

Good morning.

Thank you for joining us for the recap of our second quarter fiscal year 2005 results.

Here with me today are Jim Hackett, our President and Chief Executive Officer;

Jim Keane, our Chief Financial Officer and Mark Mosing, Vice President and Corporate Controller.

Our second quarter earnings release dated September 23rd, 2004 crossed the wire earlier this morning.

That same release is accessible on our website.

This conference call is being webcast.

Presentations slides that accompany this webcast are available on steelcase.com.

A replay of this call will also be posted to this site later today.

In addition to our prepared remarks, we will respond to questions from investors and analysts.

At this time, we are incorporating by reference into this call and subsequent transcripts the text for our Safe Harbor statement has been incorporated in this morning's release.

Certain statements made within the release and during this conference call constitute forward-looking statements.

There are risks associated with the use of this information for investment decision-making purposes.

For more details on these risks, please refer to this morning's release, form 8-K and the Company's form 10-K for the year ended February 27, 2004, and our other filings with the Securities and Exchange Commission.

This webcast is a copyright production of Steelcase, Inc.

Any reproduction, publication or rebroadcast without the express written permission of Steelcase is prohibited, Copyright 2004, Steelcase, Inc.

Now I will turn the call over to our President and CEO, Jim Hackett.

Thank you, Terry, and good morning to all.

You'll be hearing throughout this discussion this morning that this quarter's news is very good.

As we forecasted the year last spring, we did see some variables that could swing our way.

That did come to pass, but it doesn't tell the whole story, in terms of the basis for all of this improvement because I'm quite proud of the fact that Steelcase did a lot to control its own destiny.

You will also be hearing about the pressures we face in the business that will tend to temper some of the recovery.

I am asking our employees to understand that the past recession is over and that the last two quarters' results show that we're doing a good job and on track to finally pull away from the gravity of that unprecedented capital recession.

Let's talk about some indicators that describe the rhythm of the improved performance.

There are a number of large projects that have been won by Steelcase and many shipped this year.

One of note is the decision by the U.S. government's TSA division to use our product to modernize its important governmental department as the country builds a security infrastructure for the protection of its citizens.

It is true that our projections that as the prison industry reform took hold, we would see a benefit at users understand our value proposition and that Steelcase would be the winner in many of these large projects.

This is a very large project and it involves the operations for TSA all over the United States.

Our strategy of integrating architecture, technology and furniture is also part and parcel why our largest account base is up in sales over 25 percent this year.

I'm not ready to declare that this growth rate will continue through the whole year, but evidence in the first two quarters means that we will be gaining back some lost share to the segments that were smaller customers during the recession.

However, with regard to the potential of the smaller customer segment, Steelcase is clearly staking out efforts to improve our performance in these smaller customers segment.

There are indicators to date of progress in that area.

Sales of our Turnstone brand that targets the midmarket are up 20 percent year-to-date versus prior year, much faster than the industry growth at large.

Also, in a newly announced partnership with Henry Schein, it has allowed us to reach a customers segment we have not historically had easy access to, which are again, part of the small customer segment.

There are other ideas that are poised for implementation and will be reported on in future calls.

My purpose in vaguely referring to them is to assert that this segment will be part of our future plans as we have the benefit of the growth in the large customer segment now happening.

Additional good news that underlies our renewed results will be reviewed by Jim Keane, particularly some discussion around customer visits that are improving.

We also feel great about the acceptance of our new Think chair, which was launched at NEOCON (ph) this past June, and how our dealer channel is now prepared to win with his chair.

The chair started shipping just in mid-August and so far appears to be ahead of forecast.

It's also a notable signal that the market is responding to our strategy of building on the Company's long history in sustainable practices and as a responsiveness to our high rating as a socially conscientious company.

Customers' attitudes around these softer issues tend to express this with a product like the Think chair.

Our value, quite frankly, has and will be in our ability to use our insights into the work effectiveness in people and organizations.

We've invested millions in this science and we're able to translate it across the other industries that obviously benefit from better work science.

Sales in key vertical markets like health care, which represent some of the fastest-growing segments of the market, have benefited from this work.

Finally, it's worth noting that one of our largest initiatives in building a made-to-order supply system that is global using lean manufacturing concepts has taken hold.

It has delivered notable results this quarter and I cannot tell you how massive that work has been and it is nothing short of astonishing to imagine doing this in the midst of a recession.

But we did, and it is showing the benefits we projected.

They have new challenges.

For the first time in roughly 25 years, we see a continuous pinging of commodity increases.

News in the Journal this week is talking about some corporate earnings changes in the consumer business as they grapple with increases in raw materials.

You will recall that Steelcase led the industry with the concept of a steel surcharge and at the time, it was a bit controversial.

There was comments from the market, our competitors, that pledged to avoid the charge with better productivity measures.

We did not believe that would be possible and, basically, we see the industry at large dealing with the price increase as a way to deal with commodity increases, like steel.

Not dealing with commodity increases is problematic; in fact, I would say, quite dangerous, and that is it's a difficult path because it has not been part of the corporate cultures to manage the peening (ph) of commodity increases.

You really look back 25 years, and it has been relatively stable.

In the world of commodity increases, you either stay ahead of them in your pricing or you don't, and if you don't, you will suffer loss income.

So Jim Keane will cover the prospects of dealing with this and how the Company has positioned itself.

I will come back at the end of the session just to further confirm why I think things are better and how proud I am of the performance of our employees.

I would like to thank you again, and now I will turn this over to our Chief Financial Officer, Jim Keane, who will review our quarterly financial performance in much greater detail.

Jim?

Thank you, Jim.

Today, we reported a second quarter profit of $7.3 million, or 5 cents per share on the sales of $651 million.

Sales were about as we expected, but our profitability was much higher than we had estimated.

Gross margins were stronger and we did a good job controlling operating expenses.

The North America business in particular showed a significant improvement in profitability.

The 7.3 million profit was the highest level of income from continuing operations since the fourth quarter of fiscal 2003.

And by the way, that quarter included significant gains on the sale of our Tustin facility and other items.

So not counting that quarter, it has been more than three years since we've had a quarter with a higher level of income from continuing operations, and we're very pleased with this performance.

Sales of $651 million represents an increase of 6.4 percent versus the prior year and 8.9 percent versus the first quarter.

Remember that year-over-year comparisons benefited from $21 million in consolidated dealer revenue and about $8.6 million related to currency translation effects.

Second-quarter revenue included about $8 million related to the steel surcharge implemented in the North American segment.

The sequential quarter comparison is not affected by the newly consolidated dealers and there's very little currency effect.

So that is the story on revenue, and again, revenue was in line with our expectations.

Now we'll talk about profitability.

The $7.3 million profit we earned this quarter companies to a loss from continuing operations last year of $3.2 million.

Remember that last year’s net income of the $18.1 million included the gain on the sale of Attwood.

This quarter's results included restructuring charges of $1.4 million after tax.

That was about $3.5 million less than we had estimated because certain restructuring activities already underway will be completed later than originally estimated, and because we were able to complete other restructuring activities at a lower cost than originally estimated, and that is a big deal.

The people who are working on these restructuring activities are finding ways to save money, and it is reflected in our performance.

The webcast slides include more detail about these restructuring charges, including a breakout by reporting segment.

Our cost of goods sold improved significantly this quarter to 69.8 percent, versus 71.4 percent a year ago.

That is an improvement of 1.6 percentage points.

As you know, we've been working on consolidating facilities for the last three years.

We have been saying that much of the cost of these consolidation initiatives was behind us, but the benefits would not be seen until the operations had a chance to stabilize.

This quarter, there was much restructuring activity in many of our steel plants in North America and we're seeing better gross margins than we have seen in some time.

Our international plants were still going through restructuring changes during the second quarter, but still saw some productivity benefits start to flow through.

Our wood plans in North America are in the middle of a consolidation project that will continue through the third quarter, and while benefits are starting to flow through, we won't see the full benefits for at least another quarter.

We have also been making progress at implementing lean manufacturing, so we're continuing to see improvements in labor productivity as operations have stabilized in the North American plants.

We still have a great deal of work ahead of us to reduce complexity and adopt a less vertically integrated, more global supply chain, but this quarter we saw real evidence of progress toward our longer-term margin goals as gross margins were better than we included in our estimates.

Operating expenses of $178 million were 27.3 percent of sales.

That's lower as a percent of sales than in the prior year, despite increases in health-care costs and variable compensation expense.

When comparing actual dollars to the prior year, consider that newly consolidated dealers added $7.5 million to operating expenses and currency translation added $2.8 million.

Operating expenses were less than we had estimated for the quarter in part because spending on some projects was delayed until the second half of the year.

We are also profitable on a year-to-date basis with net income of $1.6 million after-tax.

Year-to-date income from continuing operations is positive $0.6 million, compared with the year-to-date loss of $18 million at the same time last year.

Next, I'll talk about the balance sheet and cash flow.

We increased cash and decreased debt in the quarter.

Our cash balance was $240 million at the end of the quarter, a $34 million increase from the first quarter.

We reduced debt by $2 million to a quarter end balance of $329 million.

We made some progress on improving days sales outstanding this quarter.

We have a team focus on improving our direct build process and that is starting to pay off.

The improvement in DSO freed up nearly $20 million in cash.

Now I will discuss the operating results for each of our segments, starting with North America.

In North America, sales were $366 million in the quarter.

That's a 6 percent increase from the prior year, including $15.4 million from newly consolidated dealers.

On a sequential quarter basis, North America grew the business by 11 percent and there's no effect from the consolidation of dealers on that comparison.

North America revenues included $8.3 million related to the steel surcharge.

The increase in North America sales from the first quarter was driven in part by growth in vertical markets like health care and education and because we won some major project business with larger customers.

Discounts and dealer incentives were similar to the first quarter.

North America gross margins of 25.8 percent improved more than 3 points over the first quarter because of higher volume and less disruption from consolidation activity.

Margins also improved compared to the first quarter because of the effects of the effects the steel surcharge, which offset higher steel costs during the quarter.

North America operating expenses were 23 percent of sales, down from 23.2 percent in the prior year.

Compared to the prior year, second-quarter operating expenses included $4.4 million from newly consolidated dealers and also included increased variable compensation expense.

Operating expenses of 23 percent were down from 24.3 percent in the first quarter.

Higher volume in the second quarter more than offset the increase in variable compensation expense.

North America had operating income of $10.1 million for the second quarter and has earned $3.7 million on a year-to-date basis.

STP sales were $81 million in the quarter, a 10 percent increase compared to the prior year and a 15 percent increase versus the first quarter.

The growth was primarily related to health care applications and ergonomic work tools.

STP gross margins of 39.3 percent were higher than the first quarter and remained the strongest of the three segments.

Margins increased primarily because increased sales led to better overhead absorption and because of favorable product mix.

STP operating expenses were $24 million, or 29.7 percent of sales.

This represents a significant improvement over 31.3 percent in the prior year and 32.7 percent in the first quarter.

The improvement resulted from higher volume and continued cost control.

STP operating income of $7.7 million represents a 9.5 percent operating margin.

That is the highest quarterly operating income for STP in the last three years.

International sales were $132 million in the quarter, a 10 percent increase compared with the prior year.

Current quarter revenue benefited from $8.6 million in favorable currency effects and $5.6 million from newly consolidated dealers.

Second quarter sales were 2 percent lower than the first quarter, which reflects the typical seasonal pattern because of summer vacations in certain markets.

International gross margins were 32 percent, a significant improvement over the 23.2 percent in the prior year.

Current quarter margins include a gain of $1.3 million related to previous restructuring activity which had the effect of increasing gross margins by 1 percentage point.

The remaining 8-point improvement in gross margins was a combination of higher restructuring charges last year and the benefits realized from prior restructuring initiatives.

International operating expenses were $44.2 million in the quarter versus $39.1 million in the prior-year quarter.

For purposes of this comparison, the current quarter included $3.1 million in higher expenses from newly consolidated dealers and $2.8 million in higher expenses because of currency translation.

Current quarter expenses are up slightly from the first quarter because of increased product development and launch expenditures.

The international reported an operating loss of $2.5 million in the quarter.

Now I will review our order trends and (technical difficulty).

Orders in North America strengthened during the spring and appeared to flatten out in June and July.

Now we know that around this same time, the overall economy also hit what U.S. economists have referred to as a soft patch.

Since early August, North America orders have begun to grow again, but very slowly and competitive pricing pressures are intense, particularly on larger projects.

Internationally, the economies of Germany and France remain in a downturn and although things have stabilized, there is no clear sign of a significant recovery.

We are seeing some modest growth in other markets.

For Steelcase, Inc., we expect our third quarter sales to be consistent with the second quarter as modest increases in order rates are absorbed into backlog.

Third quarter sales are expected to be about 4 to 8 percent higher than the prior year.

Now for profitability, we are expecting to earn a profit between breakeven and 5 cents per share in the third quarter, which includes $1 to $3 million of after-tax restructuring costs.

The third quarter profitability is expected to be slightly lower than the second quarter for a few reasons.

First, I mentioned the intense pricing pressure we are seeing in the marketplace.

Based on orders already in-house that will ship in the third quarter, higher discounts are expected to reduce pretax operating income by $2 to $3 million as compared to the second quarter.

That could change, but that's what we're seeing right now.

Second, material prices are rising rapidly with steel leading the way.

Steel prices are currently 15 percent higher than when we announced the steel surcharge six months ago.

We expect higher steel prices to reduce third quarter pretax profits by about $2 million for the greater effect in the fourth quarter.

And, we are seeing increases beyond steel.

Rising energy costs and other factors are increasing the cost of plastic, fabric and other raw materials.

It's not clear if these are short-term or longer-term issues, and there are a lot of economy debate on this question over in Washington.

We're continuing to monitor these developments and we'll work with our suppliers to minimize the impact.

But in the short run, these increases could reduce our third quarter pretax profits by another $2 million.

So we're getting squeezed right now from both sides.

Our net prices are under pressure, and yet we're having to pay higher rates for raw materials and energy.

The combination of these factors will likely lower our variable contribution margin.

Finally, we expect to see increases in our operating expenses during the third quarter.

Some of this increase relates to spending originally expected in the second quarter that was shifted to the third quarter.

As I mentioned earlier, that is part of the reason the second quarter results were so strong.

The third quarter operating expenses will also include increases related to new product development initiatives and other growth and process improvement projects that are key to our long-term profitability.

Now helping to offset these factors is a continued emphasis on improving productivity through lean principles, both in our operations and in our offices.

So although we expect to see profits get squeezed, we still expect to be profitable in the third quarter.

In summary, we have some challenges ahead and we're ready to address those challenges, yet we just finished a good quarter with better profits than we have seen in quite some time and with evidence that the things we've been working on here at Steelcase are paying off.

I'll end with one more piece of positive evidence.

We believe customer visits to Grand Rapids provide some indication of project business that's on the drawing board.

Our customer visits in the second quarter were up 15 percent from the prior year and up about 30 percent from the first quarter, and that is a very good sign.

Now we will turn it over for questions.

(Operator Instructions).

Matthew MacColl, BB&T Capital Markets.

Good morning.

A couple of questions, if I could.

First, you mentioned a few things about your lean transition.

If you could give me a little bit more update on where you stand there, maybe some quantification of the progress, the number of plants, number of lines, I guess maybe the average at any (indiscernible) overall in your lean transition?

Second part of that question -- talk about the further improvements that you expect from this transition quantitatively or qualitatively.

And then finally, discuss some of the biggest challenges you have faced and are facing and how you're going to handle them going forward?

Okay, Matthew, it's Jim Hackett.

I'm going to take one of the three, and Jim Keane will talk a little bit more as detailed as we can about the payoff of this.

First of all, the lean concepts are always denoted as a journey.

It is a concept of continuous improvement, and it begins with literally taking our people in the shop floor along with the supervision through very detailed training, process improvement, mapping and prototyping.

These exercises are quite enthusiastic and create a stronger community at Steelcase.

We have people involved frankly in the process, laying out factories, laying out their work cells.

And virtually every factory in our system now reports up to one senior executive in the Company -- Mark Baker.

Mark has made it a priority that every one of those nodes on the network, so to speak, will have been through lean training.

And I would say almost to date, we are there.

There will be a few yet that have not been touched, but very few.

And it's a massive undertaking, because you're talking about tens of thousands of people

Right.

The second part of the initiative involves product rationalization, because we find that one thing that fuels an improvement is if we can reduce the complexity.

So there is a massive effort and study into the complexity of the product lines and some significant work is being done there that is definitely going to help the lean processed being put in place.

The third thing is that this translates obviously beyond the points at which we touch the product, but into our supply systems.

And there is as much work done in that area around the globe as there is inside our factory.

So when I talk to you about the efforts to date, they have been incredibly complex and broad.

The challenge that you asked me to comment on is that it is a big effort.

And initially, I would say this is not the case today.

But initially, it was a bit of a distraction, because we literally had to kind of move the physical properties in many of the plants into this optimized flow.

And so the last two years, there was a fair amount of Jim Hackett: And so the last two years, there was a fair amount of reporting on that disruption, a fair amount of charges taken and we are not done with that, as Jim will talk about.

But a bulk of that has kind of passed through the system.

So that's a summary on one and three; and Jim, do want to take a shot at --?

Sure.

In terms of the benefits here, the outcome of the work we have done so far -- one indicator -- when we look at plants that have been implementing lean, but haven't been as involved in restructuring activities over the last year, year and a half.

As we look at those plants, we're seeing productivity improvements, labor productivity improvements, of 15 to 20 percent versus where they were two years ago.

And we attribute a lot of that to lean.

As Jim says, lean is part of this, there's other things going on that we're doing to improve productivity.

But it's a big part of it.

So, we're definitely seeing impact in that way.

And then when we look over the longer-term, all of the things that Jim talked about -- rationalization of plants to reduce excess capacity, implementing lean, reducing complexity, adapting a global supply chain, adopting a global supply chain -- all of those things are intended to help us achieve a gross margin that we targeted for 35 percent out a few years.

So that's where we see the payoff, is in that longer-term.

Okay.

Second question -- talk a little bit about the replacement cycle versus new orders.

I'm assuming there's a lot of replacement demand that's pent up out there where people delayed during the downturn.

Do you think that, even though every economic indicator has not wholeheartedly moved in the right direction, everything is I think getting there, but do you think that you will see some improving replacement demand, or are you seeing improving replacement demand versus a new order demand increases?

Matthew, I would say that the recession definitely caused a pent-up of demand.

And it's our belief that a much of that will come out over time.

They have to -- many of these corporations have to make some of the adjustments that they were able to put off.

Some of our studies show that as you know, we have a number of different categories of furniture.

So the replacement cycles are different.

But the workstation cycle being the largest had a turnover around every 15 years.

And I would say that the Y2K was the culmination of the completion of that first big replacement cycle in systems furniture industry.

It doesn't mean that we're now waiting for 15 years from there for that all to happen, because these cycles get accelerated based on technology and work science change.

And we believe that the other segments that would in the seating have shorter replacement cycles; they can be more fashion-driven or more or performance-driven.

People are willing to trade in a chair that's still quite productive for something that fits them better.

And so we are investing in the case of seating, a fair amount in seating science to further spur demand.

And then, finally, and I have to make this comment around the world, there's markets that are new, in terms of demand that just don't have the inventory of furniture at all, and those are attractive as well.

The price points are much lower there, but there's still a fair amount of demand.

So when you add it altogether, we see BIFMA, which is the industry group that projects the growth -- BIFMA is now steadily stepping up their projections.

Terry, you could summarize next two years, what those are, we'll get those and we'll --.

I think they have 11.5 percent next year. (multiple speakers)

They have modified them.

But, you would see in sequence, obviously, they're growing again year-on-year.

And so I think it supports your instincts that there's pent-up demand and replacement going on.

I have one final question, if I could.

You mentioned a little bit about pursuing the middle market a little bit.

Could you add some color to that?

How much does Turnstone represent of your income?

Where do you plan on -- of your topline -- where do you plan on moving that?

Give us an example of how you're going to pursue some improvements there?

I have to plead that I don't want one to share that for competitive reasons, but I will give you this, Matthew, that the Turnstone growth rate is, as we quoted, is over 25 percent this year.

Last year, it was in excess of 20 percent and both of those growth years were in the midst of the downturn.

We think that clearly having this brand targeted towards value-oriented products and smaller customer segment has proven to be right on; hence, their growth.

We also did publicly announce a relationship with a distribution entity called Henry Schein.

They lease dental and small medical practice sites.

So it is a large segment of the population of small customers.

That's too early to report, in terms of any material information.

But, a lot of the effort has started and things are going well.

And then as I mentioned, a lot of the work that we have begun to undertake is around thinking about different ways to reach the smaller customer segment.

And the one thing I can assure you is there is a great deal of interest in some studies we've done for Steelcase, Inc. products in those segments.

Many of the customers want access to it.

And so, we have to try and make it easier for them to get these products, and those will be part of the plans that we address later.

Okay, thank you very much and good luck.

Robyn Bodde (ph), Olsen (ph) Capital Partners.

I just wanted to focus in on this revenue growth.

You talked about wins in your health care and education sectors.

But, if I were to back out (indiscernible) gains from steel charges and favorable currency, as well as the 21 million from dealer consolidations, (indiscernible) relatively flattish year-over-year sales growth.

And I was wondering if you could comment on that?

And then also maybe, if you could comment I guess which sectors have been weaker than you expected?

Robyn, when you're thinking about that relative to the industry, they would have those same forces as well, right?

They would have price increases, they would have currency adjustments and so on and so forth.

So are you asking the question now as Steelcase relates to the industry, or as it's year-on-year?

I guess as year-on-year for you, and then, but they wouldn't have $21 million of dealer consolidation.

So, if you were to exclude -- right?

So, if you were to exclude those other two charges (multiple speakers).

Well, there are dealer sales in some of the other companies reporting, so I don't know the exact amount.

But, I'm asking the question more of -- are you concerned about the quality of the revenue growth, or are you concerned that it -- because it is right now pacing faster than the industry.

No, I'm just trying to figure out what areas were weaker -- I guess corporate, you're saying, was probably weaker than expected if you're getting a lot of these gains from health care?

I'm just trying to figure out on an apples-to-apples basis compared to last year, if you (multiple speakers) health care and education, where did you lose, and maybe why?

I think that, in general, the corporate capital spending has been down over the last three years.

And when we were at this point last year, we were still seeing revenues decline from the second quarter, for example, into the third and fourth quarter, first quarter this year.

So we're still on that sort of a trend.

So when you compare to last year, you're comparing to a specific point that quarter, and we were seeing softening going on at that time.

If you compare what we just -- this quarter, we just had to the prior quarter, so this first quarter of this same year, we are seeing strengthening that is beyond normal seasonal strengthening.

And that is what we are referring to when we're talking about the growth we're seeing in healthcare and education.

And we're also seeing growth, as Jim said, from our large corporate customers.

It's the first time we've seen that kind of growth really throughout this downturn.

So -- and versus expectations, actually expectations, our revenue's streaming right on our expectations this quarter.

So we weren't surprised one way or the other.

We expected health care and education to do better and it did, we expected our large corporate customers to start spending more and they did, we won some big projects as we mentioned, so it wasn't a surprise to us.

And do health care and education have higher or lower gross margins, would you say, than a corporate project, or is it completely depending on the mix of what they order?

It really depends on the mix of what they order, the size of the order; those are the things.

But so far, we've been very pleased with the profitability we see as we go into those new segments.

So you shouldn't think of it as having any kind of a negative mix impact.

Okay, great.

Thanks guys.

Andrew Gundlach, Artemis (ph) Capital.

Good morning.

I wanted to go back to the statement that you made about your 35 percent gross margin target, as well as the earlier comment on how your contribution margin might have changed with the variable costs going up.

Firstly, the 35 percent target -- is that at current volumes and mix, or how are you thinking about that target?

The 35 percent is a three-year target, first of all, and it is based on assumptions of revenue growth, but single-digit percent annual revenue growth.

So we are not assuming any kind of a major recovery in the industry in order to hit that target.

So, it's 3 to 5 percent volume -- would that be fair?

I'm not going to quantify it, other than -- it's single digit.

But, the purpose of that is not to give you a sense of when we think our volume is going to grow (multiple speakers).

You really, you put something into your top line in order to establish a gross margin target.

It would be easy, frankly, to hit gross margins if your volume is growing at double-digit rates. (indiscernible) just make sure that it's things that we can control that get us there.

We're using a fairly conservative assumption of top line growth.

In fact, I would like to add, Andrew, to connect to Robyn's question that it isn't just a recovery of the industry that caused the Company's improvement in earnings.

As you can tell, it is based on many of the initiatives we took trying to get cost in line and to give factories repositioned around lean.

So what all of us believe is that the industry does return into some of the growth patterns that BIFMA's projecting.

There is a chance for a lot better earning potential.

So, when you say -- so, that target includes, when you say revenue growths of 3 to 5 percent, you mean at constant makes and price, or are you assuming a little bit of price in there, too?

Let me go back and make sure that I was clear.

So, 35 percent is the gross margin target.

But I did not give you a revenue growth percent.

I simply said single-digit revenue growth.

But, the single digit is at constant price and mix?

The single digit would assume normal price increases and normal continuation of discount trends.

It would consider existing mix, but it also considers some of the things we're doing with our business as we move into new markets that Jim talked about before.

So, we consider all those things when we come up with that number.

But I would also tell you, just to underline it again, that growth percent that we picked was not the news of that exercise.

The news is -- if you assume fairly modest growth, then we still want to be able to hit that 35 percent gross margin target.

So I would put more emphasis on the 35 percent part of this than on which growth number we picked.

Totally.

But, my next question was more on capacity utilization.

Where are you today, and where do you think you will be two or three years down the road when you have finished your rationalization?

There's no problem with capacity in the system today, and that's after taking 47 percent of the floor space out since 1998.

We still have plenty of capacity because of the link systems.

As you implemented lean, you find that you need a lot less space for inventory, a lot less space for a lot of stuff.

So we're able to do the same amount of production that we did several years ago with a lot less space today.

And we think that's going to continue.

We're not anywhere near being tight.

So, would you consider your utilization today to be in the 60 to 70 percent range?

It's probably about 50 percent; it's probably less than 70 percent.

And two to three years out, how much more floor space do you think you can take out?

I don't want to speculate on that right now, but I would say that as f we continue to implement lean, we will find ways to increase the floor space productivity.

And that's embedded in your 35 percent target, so that's additional?

yes.

We consider in the 35 percent target all of the things we talked about before.

So, the rationalization of excess capacity, implementation of lean, reduction of complexity, moving to a global supply chain.

There's a lot of work that has to happen, by the way, between now and then to get the 35 percent, but we do have plans for getting there.

Lastly, help us understand your contribution margin at current mix and the raw material prices.

Forget about what resin has been doing the last few months, and stuff like that.

As an outsider, it's almost impossible to figure out, given how much you've changed the manufacturing footprint of the business; if you can give us any indication what do you think your contribution margin is, it would be very helpful.

I think our contribution margin, not counting variable compensation expenses; we've been saying 50 percent.

It's probably 47 to 50 percent, somewhere in that range throughout the downturn and during the recovery.

If you include variable compensation expense, which I would include if I were you, we've been saying 35 to 40 percent variable contribution margin.

And given the increases we're seeing in raw material prices, plus as we mentioned we're seeing some discount affects as we go into the third quarter, we're probably at the lower end of that range, probably closer to the 35 percent side than the 40 percent side.

And again, this is not an exact science so we're giving you estimates here.

But, I would say we're at the lower end of that range.

And steel versus resin as an input?

You have to be kind of the opposite of Herman Miller, right, where they are more resin and less steel, and you're probably more steel, less resin?

All of those factors make their way into the product, whether it's something that a supplier purchases or something the Company purchases itself.

So in the long run, it effects your cost regardless of who's doing the buying.

I would say for us, we are seeing -- steel is always going to be an important component and the increase we've seen in steel prices has just been phenomenal and unprecedented in some ways.

So that is by far the greatest impact.

But we are seeing increases as we said in other things like textiles, plastics, energy, and those increases are going to affect us as well.

So, would you say steel is like 20 or 30 percent of your contribution mix, just to get a sense of how these things might affect your margin?

I'm not going to quantify it for you, but I would say -- the (indiscernible) in steel price has by far been the greatest material increase we've seen.

Thank you for your help.

Margaret Whelan, UBS Securities.

Good morning, guys.

Some of my questions were answered already, but I guess I was just wondering -- your decision to put in a per charge rather than to raise your prices altogether was unique in the industry and I'm wondering if you have seen any benefits or repercussions because of doing that?

The benefit is we can have a very honest conversation with our customers about what was causing the increase.

The customer has understood if we had virtually 100 percent acceptance, I'd say 100 percent, except I just never know about that last 1 percent.

So those conversations weren't -- I'm not going to say they were easy conversations, but after you get the fact from the table, you can explain to customers what is going on.

The benefits of the shareholders is that the impact of the surcharge was immediate.

Once the orders -- once we passed that deadline, all orders placed after that deadline have the surcharge.

So in a very timely way, we could have our revenues adjust to what we were really -- what was really costing us to buy all of this steel at a higher price.

So that's a second benefit.

And the third benefit is, for our customers and for everybody, I think the steel price has come back down and we have a specific point at which the surcharge comes off again.

So we're not trying to make a profit on this; we're trying to simply offset our costs.

When you put in the surcharge, did you put it in immediately, or did you give them time?

Did you give them like 60, 90 days or anything?

Absolutely, we gave them time.

So first of all, we waited a little bit.

Steel prices were rising, we came up with this option, we wanted to make sure that the steel price that we were paying wasn't just a temporary thing before we went and approached our customers, and we should absorb some of that as a good supplier, and we did.

When we began the conversations with customers, we gave them 60 days, I believe, for the conversations to take place and for customers to consider whether there was project business or something that they wanted to pull out and place before the surcharge took effect.

And so we provided some time for that.

And going forward, if and when steel prices break, are you going to have a lag between the time that you take off the surcharge or remove it versus when those prices start going down?

We're just going to watch that steel price index.

And if it's the same, a level below the particular cutoff number, I forgot what it is, then the surcharge comes off.

The second set of questions is just that you have done a good job of consolidating capacity and we're close to the tail end of that.

How are you thinking about CapEx run rate versus your D&A and what use the cash will be going forward?

Our capital expenditure has been well below $100 million per year here for a little bit.

For this year, we're it to be below $100 million.

And I actually believe, even in a growth scenario, we can maintain at least for another year capital expenditures around $100 million or under.

And the reason isn't because we are serving (ph) the Company; the reason is because with lean manufacturing, we find that we can launch new products with a lot less capital than we required in the past.

Just the whole way we approach the tooling of a new line is different for lean manufacturing.

Secondly, when we launch a new product (multiple speakers)

-- being different, does that mean it's more expensive?

It's less expensive from a capital perspective, so you tend to -- if you buy equipment, you tend to buy smaller pieces of equipment than if you increase capacity.

You just do it in a different way than the way we'd have done it before that was built around very large, high-capacity machines.

So it's a less risky strategy if you launch new products, but it's also just much better from an EVA perspective.

The second reason is when we launch products like the Think chair, we're immediately going to a global supply chain approach, which means that suppliers around the world, they're making components that we use to tool up for ourselves.

That also has an impact of being able to keep our capital expenditures lower.

And what about the dividend (technical difficulty) company years ago -- would you think about raising it again?

No, the dividend is a board decision and the dividend in the long run is going to be related to longer-term company profitability.

And that has been the principal that the Board has used in the past.

And the board has committed that dividends are an important way for us to return value to shareholders.

Other than that, it's their decision, so I don't get to speculate.

Is there any profit level or threshold at which they're going to think about it, or it hasn't been determined yet?

They haven't set any rules like that, and they will evaluate the dividend each quarter.

Okay, thanks.

Well done.

Budd Bugatch, Raymond James.

Good morning.

I have a couple questions.

Some of these are housekeeping.

Inventories up I think year-over-year around 9 percent.

Can we get the composition of inventories, Jim?

You mean by raw materials and so forth?

Yes, what has caused it?

I mean, revenues were up 6, inventories up a little higher.

You had last year about $31 million of LIFO credit.

What's in it this year?

I would tell you, there's two things that would cost inventories to be higher than a year ago.

The first would simply be currency translation.

So the inventories that related to international would be up because of that.

And the second is because of steel.

So the steel prices rose, even though we may not have an increase in the absolute amount of steel, we have an increase in the value of that steel inventory.

So those are the two factors.

It's probably a combination of volume too in the plants.

And while we don't have any issues with securing steel, I think we are carrying a little more safety stock then we otherwise would, Budd, given the current --.

What has changed in LIFO?

The LIFO has not changed significantly at this point.

We're going to be doing a more complete analysis toward the end of the year based on where the steel prices end up.

In the long run, though, we are seeing improvements in inventory turns.

Particularly in North America, when thinking about data we looked at recently, plus our work in process and raw materials; we've seen some improvements and we hope those will continue as we implement lean.

Mark or Jim, what about goodwill?

We're looking at $294 million.

Where's the location of it, what's at risk for the year-end calculation?

The components are spread among the acquisition pieces, but the biggest piece is probably associated with our Polyvision acquisition.

We still have goodwill associated with our international.

But that's an annual assessment based on our future cash flow projections, so I don't really have any comments, other than it's stated safely where we think it should be right now.

How much of the 294 is offshore?

Probably less than 100 million at this point, Budd.

You don't think it's at risk if Europe is not getting any better?

Again, it's based on the cash flows of that business, so we don't think it's currently at risk.

Okay.

I want to just go in a little if I could into the margin issue.

I know the 35 percent target in three years, and we had in 1997 and 1998, I think we got a little over 35, 35.5 percent gross margin.

What about on an operating margin basis?

We got to 11 percent in '98, if I remember right.

What is an operating margin target, Jim?

The operating margin target is 10 percent of sales.

So if you take those two numbers, it's 35 percent, gross margin target 25 percent, operating expense target, and they combine for 10 percent after the income (ph) target.

That worries me, because then that would get an ROIC, if I did my numbers right, on (indiscernible) on an ROIC of just about 10 percent too, based upon the capital that is employed right now.

And that's not a great thrill.

Obviously, we don't see positive EVA now.

What do we do to get the ROIC up?

What's the right ROIC target?

Shouldn't it be mid-teens?

Well, I just don't have the calculation you did, but I would say that a 10 percent operating income percentage is pretty good for us, so it's a good target.

It targets historically for us.

The other half of the formula obviously is invested capital, right?

Right, and right now, it looks like it is about 1.5 billion.

So, think about all of the things we've been doing to reduce capacity to rationalize capacity, the idea that as we grow the company, it is our expectation that capital expenditure will be running at a lower rate than maybe they have in the past.

The belief that through lean manufacturing, we're finding ways to improve safe (ph) utilization better than they ever were in the past.

And also, we're doing work on working capital, as I mentioned before, looking at ways to improve our receivables, our inventory turns, payables.

We have work ahead of us on those fronts.

But getting to a better ROIC isn't simply a matter of operating income.

Oh, I'm well aware of that.

That's why I'm asking the question -- what do you do to extract capital out of the business?

And, how much capital can you extract out?

There's nothing sexy about it.

It's just about working your working capital, making sure you're doing the right things.

We have a number of initiatives going on to improve working capital.

And also, again, space utilization.

We have historically been a vertically integrated manufacturer, so a lot of those assets that you're talking about are manufacturing assets.

And so we have to convert those assets to cash to extract the capital, and then the question becomes, okay, what do you do with the cash when you do extract it?

How do you return that?

What's the right cost of capital?

What's the right debt to capital?

What is the right debt to capital target?

I'm really looking forward to those days of --.

I hope so, too.

It's a front and center issue with me.

It's something that we do talk about, we do have goals.

The Board is quite involved and active in the dialogue about that.

And, I would say to you that if you thought about it, the rhythm that we've actually pursued has put us in great position to attack that question.

Because you have to start with the global supply system in a state that required a lot less capital.

And that journey started and results today kind of show you that progress.

What Jim is also suggesting is as we look at the fulfillment systems through our distribution and into the spires (ph), there's a lot of opportunity for leaning out capital there.

Our net debt to capital right now, you net out the cash, is not particularly a challenging -- your net debt to capital.

You have to be reducing the cost of capital.

If you are not going to get an ROIC up into that mid-teens level, then you have to get the cost of capital down to come up with a positive EVA that is attractive, don't you?

Yes, but I think, again, it's that a matter of reducing the amount of invested capital or reducing it as a percentage of sales (indiscernible) more efficient.

And that really is the heavy lifting part of this and we are working on that.

By when should we see those results?

It's obviously to set a goal.

You haven't told us what the goal is. (multiple speakers).

We haven't, because it's all a part of our management incentive plan for our people.

It's an important measure that's confidential to their compensation.

But I guess what I want to assert with you is that it is front and center a priority in the leadership team.

I would encourage you to kind of tell the investment community, give us some numbers and a date by when.

That has been an area where I have not been able to quite get my hands around for you all.

One other question I have is -- can you give us the A and the B shares outstanding at the end of the quarter?

I think we're at 97 on the B right now.

So, same as last quarter?

It has not changed significantly.

From quarter one to quarter two, I think it went up by about 3 or 4 million.

We will call you back with that number.

Because I saw the form force (ph) filing.

Thanks.

Kirby Wallach (ph), Fifth Third Investments.

Hi, guys, good quarter.

Actually, you have addressed most of my questions, but I have a couple of follow-ons with the steel surcharge.

And Jim, you talked about this a little bit, as far as the pushback that you've gotten from customers.

I wondered if you could give us an idea of what do you feel that's still a sustainable strategy?

It seems like it has worked great so far.

And secondly, I'm curious if it's tied to the steel price and it sounds like it is, you mentioned that steel prices are up 15 percent since you put it in.

And I wondered if it was a variable surcharge that kind of climbs along with the price?

And then thirdly and I'm finally, I wondered how much of that surcharge goes through to the customer and how much gets stuck at the dealer?

I'll talk about -- first of all on the pushback, we said we've actually had very good acceptance, something like more than -- close to 100 percent of our customers (indiscernible) surcharge at this point.

And although again thy were conversations, you have to sit down and explain it, people do understand.

And so that's the first part of it.

Secondly, it's not a variable surcharge; it is a fixed surcharge, and it was fixed based on what we saw the rate at the time we established it.

And then there's a trigger point that has to do with the steel index.

I don't know the specific index, but it's a steel index.

And as that index price comes down below this threshold, then the surcharge goes off completely.

So it's a binary kind of a thing; it's either on or it's off and it doesn't cork up up-and-down.

Then what was the third part?

Customer (indiscernible).

I don't have a lot of visibility into that question.

The conversations, as I said, that we were having with the customers, and so my expectation is that by far, that's -- the customers are paying that surcharge.

Okay, thanks guys.

There appear to be no further questions in the queue.

Do you have any closing comments that you'd like to finish with this morning?

Yes, I do.

It's Jim Hackett.

When you look at the 12 quarters that we've labeled as time in the recession, you would see the foundation of initiatives for much of the improvement we were able to report today.

And because Steelcase is a collection of geographies and businesses and brands, it's safe to say they all work through this recession, a task that you could say either makes you better or worse.

We're hopeful that you see that we're better as a result of the recession.

What you likely won't be able to see is the light of our people and management team, to see that the hard work pays off.

The positive morale boost begets more ideas, initiative and confidence.

These are all valuable for the Company's health and help explain why demonstrative results are so vital to our recovery.

Our focus is to translate our insights of work science into building a better work experience; to leverage a can-do attitude that has always been part of this great company.

Thank you for your attention today.

Thank you, ladies and gentlemen.

This does conclude today's teleconference.

You may disconnect your phone lines at this time.